SWP Vs Dividend Plan: Which Mutual Fund Option Is Better?
The popularity of mutual funds has increased rapidly in India in the past couple of decades. According to a recent report, the total AUM (Asset Under Management) of Indian MFs surpassed INR 67 trillion in October 20241. As an investor, you can choose between SIPs and lump sum investment modes. MFs, with high returns and multiple tax benefits, can be an excellent tool for attaining financial goals.
For this, you must also know the two withdrawal modes through which your mutual funds can help provide periodic incomes and help attain your financial goals.
For withdrawals (besides the lump sum alternative), you can choose between a Systematic Withdrawal Plan (SWP) or a dividend plan (also known as Income Distribution Capital Withdrawal; IDCW plan) to create an excellent source of regular income streams.
Each option has multiple pros and limitations, depending on your preferences and fund requirements, which option you wish to choose. This article will help you compare the two alternatives and decide which suits your requirements best.
What Are Systematic Withdrawal Plans?
Definition
SWP is an investment strategy that allows investors to withdraw a predetermined amount from their mutual fund investments at regular intervals. Depending on the fund's requirements, investors can choose a monthly, quarterly, or annual withdrawal mode.
This is an excellent strategy for investors who need regular cash flow or a passive income while keeping the remaining investments active in the market. It also makes it an excellent pension or retirement planning tool.
Example: Retirement Plan For Arjun
Consider the example of Arjun here. He is a 35-year-old IT professional looking to retire after 15 years. He currently has a corpus of INR 15 lakhs, which he plans to use for retirement. He contemplates the following options:
- Option I: Invest 15 lakhs in a MF and go for a SWP after 15 years
- Option II: Invest 15 lakhs in MF, along with an SIP of 2000 per month (in the same fund) and go for a SWP after 15 years
- Option III: Invest 10000 per month SIP in MF, and go for a SWP after 15 years
- Option IV: Invest 15000 per month SIP in MF, and go for a SWP after 15 years
Here is how SWP can help in his retirement planning:
Option I | Option II | Option III | Option IV | |
Lumpsum Investment | 15 Lakhs | 15 Lakhs | NA | NA |
Systematic Investment (Annual) | NA | 24000 | 120000 | 180000 |
Investment Tenure | 15 Years | 15 Years | 15 Years | 15 Years |
Expected ROI (Per Annum) | 12% | 12% | 12% | 12% |
SWP Opted | Yes
| Yes | Yes | Yes |
Maturity Value | 8210348 | 9105060 | 4473565 | 6710348 |
Annual Withdrawal (After 15 Years) | 12 Lakhs Per Annum | 12 Lakhs Per Annum | 12 Lakhs Per Annum | 12 Lakhs Per Annum |
Remaining Investment | 7010348 | 7905061 | 3273565 | 5510348 |
Corpus Value at 16th Year End (if reinvested at same ROI) | 7851590 | 8853669 | 3666393 | 6171590 |
Corpus Value at the 20th Year (with same annual withdrawal and reinvestment ROI) | 5931212 | 7508003 | Corpus Exhausted | 3287700 |
A lump sum investment (and a small SIP) can help attain Arjun’s retirement goals quite comfortably. A SWP can be critical as it not only facilitates periodic withdrawals but also keeps the corpus invested in the market that keeps on growing. Option III is not advisable as the corpus will exhaust roughly around the end of the 19th year, thereby not serving Arjun’s retirement planning.
Pros And Cons Of SWP
Here are the most critical advantages of choosing a SWP:
- It provides a regular income stream for investors seeking a retirement plan or passive income.
- It is a flexible investment tool with all the decisions lying in the hands of the investor.
However, you must be aware of a few limitations associated with SWPs:
- The returns are subjected to market risks, thereby making it a volatile tool, especially for retirement planning.
- If the withdrawals are larger than the returns, it can result in capital erosion over time.
- There might be fund-specific exit loads and restrictions, making SWP a bit difficult.
What Are Dividend Plans?
Definition
Another tool you can use for withdrawals is the dividend plan (also referred to as the Income Distribution Capital Withdrawal plan). As per this, a mutual fund distributes a portion of the fund’s profits or capital appreciation to the investors on a regular basis. This distribution is in the form of a dividend, thereby offering regular income to the investors.
However, the frequency of such a distribution is decided by a fund manager (and not by an investor). A fund manager might declare a dividend based on a fund’s performance and availability of surplus. This implies that there might be a significant variation in the payout amount.
Pros And Cons Of Dividend Plans
Here are a few advantages based on which you might want to opt for a dividend plan:
- Dividends result in regular income, thereby serving the investment purpose of various investors.
- Gains are realized without having the need to sell mutual fund units. The total fund corpus remains strong over the period.
On the other side, here are a few cons associated with this plan:
- Dividends are taxable in the hands of the investors, thereby reducing net returns in their hands.
- The returns depend on market circumstances and fund performance. The fund manager can even decide on zero dividends, depending on the fund surplus/deficit.
- The overall fund NAV (Net Asset Value) reduces considerably after the dividend distribution process is over.
Differences Between SWP And Dividend Plan
Here is a table showing the differences between a SWP and a dividend plan:
Basis | Systematic Withdrawal Plan | Dividend Plan |
Definition | A strategy by which an investor can make periodic withdrawals from the mutual fund. | A plan under which a mutual fund distributes dividends and surplus funds to the investors. |
Frequency | Can be monthly, quarterly or annually, as per the investor’s discretion. | Can be monthly, quarterly or annually, as per the fund manager’s discretion. |
Guarantee | Withdrawal amount is predefined, providing stable income. | Dividend distribution is not guaranteed; depends on fund surplus. |
Impact on the Fund’s NAV | No immediate impact on NAV, as withdrawals are independent of the fund’s NAV. | NAV decreases post-dividend distribution as funds are paid out to investors. |
Flexibility/Investor’s Control | Full control over withdrawal amount and frequency, customizable to needs. | No control over dividend amount or timing, which depends on the fund manager’s decision. |
Tax Benefits | Only the capital gains portion of each SWP withdrawal is taxed. | Dividend incomes are fully taxable as per individual income tax slab rates. |
What Is Best For You - SWP Or Dividend Plan?
It purely depends on your investment goals and financial needs to decide which one is best for you. A dividend plan might be suited for individuals if they prefer income based on the fund’s performance and do not have specific periodic requirements. When you trust the fund manager and do not want any fund-related decision-making in your hands, this can be the perfect tool for you.
On the other hand, if you are looking for a retirement plan, a pension scheme or a passive income, having a SWP can be best suited for your goals. You also have a lot of flexibility (and financial planning) in your hands.
It is critical that you have clarity about your level of risk tolerance, cash flow requirements, and tax situation in order to decide between the two alternatives. We advise you to look for a systematic withdrawal plan calculator and assess your financial needs before deciding on these options.
Conclusion
Choosing between a SWP and a dividend plan requires a comprehensive assessment of your financial and investment goals. Both tools have pros and cons, which we discussed in detail. If you require periodic payments and are planning for a goal such as retirement, a SWP is the perfect tool for you.
On the other hand, if you prefer seeing your investments grow and trust the decisions of your fund manager, the dividend plan is the best option for you. To reiterate, your eventual choice should coincide with your cash flow needs, risk tolerance, and tax considerations.
Frequently Asked Questions About SWP And Dividend
1. Is SWP tax-free?
No, SWP withdrawals are not completely tax-free; only the capital gains portion of each withdrawal is subject to tax, making it relatively tax-efficient.
2. Which plan is better for creating a steady income stream during retirement?
SWP is generally better for steady income during retirement, as it allows fixed, regular withdrawals customized to meet cash flow needs.
3. How do market conditions impact each plan?
In an SWP, market conditions can affect the remaining investment corpus, while in a Dividend Plan, market performance influences the frequency and amount of dividend payouts.
4. How to invest in SWP?
You need to consult your brokerage house to check which funds offer a SWP facility. Generally, most equity and hybrid plans have this option.
References
1. AMFI, Accessed from https://www.amfiindia.com/indian-mutual#:~:text=Assets%20Under%20Management%20(AUM)%20of,a%20span%20of%2010%20years.
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